Chapter 1 The Role and Environment of Managerial Finance Copyright © 2009 Pearson Prentice Hall. All rights reserved. Learning Goals • What is finance? • What do financial managers do? • Relationships between finance & economics/accounting • What is the goal of financial decisions? • The agency issue. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-2 What is Finance? • Finance can be defined as the art and science of managing ______________________________: it is the process of how organizations and individuals ___________________________ and ___________________________________. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-3 Major Areas & Opportunities in Finance: Financial Services • Financial Services is the area of finance concerned with the design and delivery of advice and financial products to individuals, businesses, and government. • Career opportunities include banking, personal financial planning, investments, real estate, and insurance. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-4 Major Areas & Opportunities in Finance: Managerial Finance • Managerial finance is concerned with the duties of the financial manager in any organization. • The financial manager actively manages the financial affairs of any organization, whether private or public, large or small, profit-seeking or not-for-profit. • They are also more involved in developing corporate strategy and improving the firm’s competitive position. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-5 Figure 1.1 Corporate Organization Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-6 Table 1.3 Career Opportunities in Managerial Finance Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-7 The Managerial Finance Function • The size and importance of the managerial finance function depends on the size of the firm. • In small companies, the finance function may be performed by the company president or accounting department. • As the business expands, finance typically evolves into a separate department linked to the president as was previously described in Figure 1.1. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-8 The Managerial Finance Function: Relationship to Economics • Finance is actually an outgrowth of economics. • In fact, finance is sometimes referred to as financial economics. • Financial managers must understand the economic framework within which they operate in order to react or anticipate to changes in conditions. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-9 The Managerial Finance Function: Relationship to Economics (cont.) • The primary economic principal used by financial managers is marginal cost-benefit analysis which says that financial decisions should be implemented only when _____________________________________ _____________________________________. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-10 The Managerial Finance Function: Relationship to Accounting • The firm’s finance (treasurer) and accounting (controller) functions are closely-related and overlapping. • In smaller firms, the financial manager generally performs both functions. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-11 The Managerial Finance Function: Relationship to Accounting (cont.) • One major difference in perspective and emphasis between finance and accounting is that accountants generally use the accrual method while in finance, the focus is on ____________________________________. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-12 The Managerial Finance Function: Relationship to Accounting (cont.) • Finance and accounting also differ with respect to decision-making. • While accounting is primarily concerned with the presentation of financial data, the financial manager is primarily concerned with analyzing and interpreting this information for decision-making purposes. • The financial manager uses this data as a vital tool for making decisions about the financial aspects of the firm. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-13 Goal of the Firm • Goal of financial decisions: maximize shareholder wealth by maximizing the ________________________________. • The market price of a firm’s stock reflects: – Expected ________________________ – ________________________ of the cash flows – ________________________ of the cash flows Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-14 The Role of Ethics: Ethics Defined • Ethics is the standards of conduct or moral judgment—have become an overriding issue in both our society and the financial community • Ethical violations attract widespread publicity • Negative publicity often leads to negative impacts on a firm Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-15 The Agency Issue: The Agency Problem • Whenever a manager owns less than 100% of the firm’s equity, a potential agency problem exists. • In theory, managers would agree with shareholder wealth maximization. • However, managers are also concerned with their personal wealth, job security, fringe benefits, and lifestyle. • This would cause managers to act in ways that do not always benefit the firm shareholders. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-16 The Agency Issue: Resolving the Problem • Market Forces such as major shareholders and the threat of a hostile takeover act to keep managers in check. • Agency Costs are the costs borne by stockholders to maintain a corporate governance structure that minimizes agency problems and contributes to the maximization of shareholder wealth. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-17 The Agency Issue: Resolving the Problem (cont.) • A stock option is an incentive allowing managers to purchase stock at the market price set at the time of the grant. • Performance plans tie management compensation to measures such as EPS growth; performance shares and/or cash bonuses are used as compensation under these plans. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 1-18